Mitigating Risk Through Environmental Due Diligence in California Real Estate Deals

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1 Mitigating Risk Through Environmental Due Diligence in California Real Estate Deals Kevin C. Mayer Harmon L. (Monty) Cooper Crowell & Moring 1

2 Outline Why Environmental Due Diligence? I. Purpose II. Roles III.Scope IV.Environmental Site Assessments Crowell & Moring 2

3 I. Purpose of Environmental Due Diligence Should be undertaken when acquiring any interest in commercial property Includes purchase & sale, finance, and corporate RE transactions Allows the discovery of actual/potential contamination Broad Liability--extends to sellers, past owners, purchasers, tenants, operators, lenders, & insurers Crowell & Moring 3

4 I. Purpose Allows parties to allocate risk among themselves in mutually acceptable ways Examines historical uses of hazardous substances at or near the property Reveals existence of hazardous building materials in property improvements Key: Scope of EED depends on property characteristics, nature of the transaction, and parties risk tolerance Crowell & Moring 4

5 I. Purpose Critical Focus: Many properties have environmental issues Without EDD, purchaser/lender may unknowingly risk loss of property value or incur liability for remediation Example: Contamination from hazardous substances is found after closing Crowell & Moring 5

6 I. Purpose Thorough EDD especially important when the property involves companies with current/past industrial operations: Petroleum Chemicals Manufacturing Automotives Energy Agriculture Dry cleaning Crowell & Moring 6

7 I. Purpose Query: What lurks beneath the surface of real property that may not have been used recently in a manner that suggests contamination is likely? Could be: Retail or educational facility built on former landfill Multi-family residential project built on former drycleaner site Restaurant constructed on former gas station site Crowell & Moring 7

8 II. Roles in Environmental Due Diligence Environmental risks will impact transaction if not properly addressed during EDD: Decreased property value due to discovery of environmental contamination (impacts seller, purchaser and lender) Later cleanup may interfere with purchaser s business operations and income (impairing ability to repay loan) Government agency may restrict future property uses Lender may be jointly and severally liable for cleanup costs if it cannot gain protection (e.g., CERCLA Secured Creditor Exemption; similar state exemptions) Lender foreclosure could lead to liability as de facto property owner Crowell & Moring 8

9 II. Roles Proper EDD may entitle purchaser to qualify for liability protections under CERCLA s Bona Fide Prospective Purchaser exemption Lender may qualify for Secured Creditor exemption Crowell & Moring 9

10 II. Roles To qualify for either exemption, an Environmental Site Assessment ( ESA ) must be conducted to examine previous property ownership and uses. ESA must: Comply with (1) EPA s All Appropriate Inquiry Rule and (2) American Society for Testing and Materials (ASTM) Standard Be consistent with good commercial/customary practice. ESA performed by an environmental consultant generally consists of a Phase I and Phase II (if necessary) Crowell & Moring 10

11 III. Scope of Environmental Due Diligence EDD should cover: Investigation into previous/current property uses and conditions, including Recognized Environmental Conditions (RECs) under ASTM standards Assessment of potential liability for on- and off-site contamination Review of compliance history and status Analysis of litigation and environmental enforcement risks Anticipated regulations which could potentially impact business Occupational/Residential health and safety exposures Federal/state FOIA requests for information not readily available Crowell & Moring 11

12 Common Disclosures and Requirements Cal. Health & Safety Code Common Law Duties Crowell & Moring 12

13 Common Disclosures and Requirements 1. Cal. Health & Safety Code Section is critical statutory disclosure law for environmental matters. Key point: Owners/lessors/sellers of commercial property with knowledge of hazardous substances on their property must give written notice of the condition to buyers. Crowell & Moring 13

14 Common Disclosures and Requirements 1. Cal. Health & Safety Code (cont.) Penalties for failure to give notice Actual damages: Buyer can subject seller to, among other things, cleanup and other costs Civil penalties: If seller knowingly/willfully fails to disclose, seller can be subject to penalties up to $5,000 Crowell & Moring 14

15 Common Disclosures and Requirements 1. Cal. Health & Safety Code (cont.) Disclosure best practices: Section disclosure can either be in purchase & sale agreement or a separate written disclosure. If based upon environmental report(s), parties should identify each by reference and/or attach copies Crowell & Moring 15

16 Common Disclosures and Requirements 2. Common Law Duties Seller also has a common law duty to disclose to purchaser certain facts that: Are known or accessible only to seller; Materially affect the value/desirability of the property; and Are unknown to or not within the reach of the diligent attention and observation of purchaser Crowell & Moring 16

17 Common Disclosures and Requirements 2. Common Law Duties (cont.) Examples of matters that may require disclosure to buyer Third-party inspection or report Any claim/notice made by seller to insurance company re property condition Unusual event affecting property (e.g., criminal activity, industrial accident) Crowell & Moring 17

18 IV. Environmental Site Assessments The Principal EDD Mechanism Consultant generally performs Phase I and Phase II ESA (if necessary) according to the ASTM standard or AAI rule. Generates report summarizing findings and recommendations in each ESA. Phase I ESAs do not alone protect parties from potential exposure for environmental liabilities. They are informational in nature and are but one element of obtaining CERCLA liability protection Crowell & Moring 18

19 IV. ESAs Phase I ESA generally includes: Tour of the property and on-site facilities Interviews of current owners/operators and neighboring landowners Review of: Agency compliance Data for permits, permit applications, compliance records, and enforcement and litigation materials; Property and area maps; Photos of property; and Visual observations of adjacent properties. Crowell & Moring 19

20 IV. ESAs If Phase I ESA suggests the site may be contaminated, consider Phase II. Phase II may include: Soil sampling Groundwater analysis Installation of monitoring wells Air sampling (including vapor intrusion) Mold sampling Asbestos sampling Lead testing; and Locating and testing USTS Environmental consultants generally conduct Phase I and Phase II ESAs on behalf of purchasers, sellers and lenders Crowell & Moring 20

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